Over the past few years one of the biggest concerns for many of our clients has been the danger of the government introducing a wealth tax. Today many of us face an even greater threat — tax by stealth.
The government does not need to incur the opprobrium of creating a new tax on wealth. It can do very nicely just by freezing existing tax allowances. We have entered a fiscal ice age at the point when it looks set to hurt savers most. Nearly all the core tax allowances have been frozen — some for several years.
Today, inflation is 7.8 per cent (including housing costs for property owners) and is forecast to breach 11 per cent by October. Few of us expect last week’s interest rate increase to give much of a boost to our cash savings. Savings accounts are lagging so far behind inflation that your cash is set to halve in real terms in around 14 years.
Our research shows what allowances would have been by the start of the financial year — April 2022 — if they had tracked inflation. More recent price rises mean the damage these tax freezes cause is likely to grow even more sharply this year.
But let’s just look at where we are now. It adds up. The worst is inheritance tax (IHT). The nil-rate band threshold has been frozen at £325,000 since 2009-10. Had it risen in line with inflation it would be £427,951 now — a difference of £102,951.
The residence nil-rate IHT band has been frozen at £175,000 since 2020-21 and, like its partner, will remain in the ice box until 2026 at least. Adjusted in line with inflation, it would be £184,867 now. For a couple dying today and leaving a qualifying estate worth in excess of the thresholds, the impact of these freezes could be £90,255 extra in IHT. It could be as much as £110,666 if you believe the residence nil-rate band should have risen in line with house prices.
On top of this, we should also remember the residence nil-rate band taper, which reduces the allowance by £1 for every £2 an estate is worth over £2mn. Had that risen in line with inflation it would be £2,244,194 today.
Turning to the living, one of the most hated tax thresholds for my clients is the pension lifetime allowance. It is considered not just punitive but also devilishly and needlessly complex. The threshold (frozen since 2020-21) should now be £1,133,606 by our calculations. This could mean an additional tax charge of over £33,000 for those breaching the limits and taking the surplus in cash. And that’s before we consider the pension contribution taper for high earners or the effects of big cuts in pension contribution limits over the past 20 years.
Income tax thresholds have barely risen since 2019, costing a basic rate taxpayer £164 this year, a higher rate taxpayer £494 and an additional rate taxpayer £2,173. I have written before about how those earning between £100,000 and £125,140 lose £1 of their personal allowance for every £2 they earn over £100,000. These people effectively pay a marginal rate of 60 per cent tax on earnings within this bracket. As wages rise, more people are trapped by it.
The taper was introduced in 2010 and has remained at that level ever since. Adjusted for inflation, it should start at £128,969 now — a difference of £28,969. This means an additional tax cost of at least £5,028 for someone losing the full personal allowance.
What can any of us do about this?
Use your allowances
The obvious first step is to ensure you make the most of the allowances available — and, if you expect to be hit by IHT, start planning now. If you are retired and can afford it, consider drawing more heavily from your general investment accounts and Isas than your pensions.
Money in a pension fund is currently ringfenced from IHT. Use any unused Isa allowance to shelter money sitting outside a tax wrapper to protect it from capital gains and dividend taxes. These tax-sheltered funds can also pass to a surviving spouse or civil partner.
Everyone has distinct circumstances and needs, but we generally suggest clients keep up to two years’ worth of annual expenditure in cash savings. Many wealthy people hold far too much in cash. Over the past decade that has not been particularly problematic, but with today’s inflation it is.
You might say that being invested in bonds and equities has not been a smart move in the past year. But history suggests that the time to invest is when it feels most painful. If investing today, consider drip-feeding money into investments to reduce the risk of bad market timing.
Give it away
Your biggest gift to your children is not to be a burden on them. Make sure you have what you need — and remember when budgeting for potential later-life care costs to allow for these to rise with inflation and then some. If you have a surplus after that, consider beginning to give it away.
The second major concern of most of my clients is the financial plight of their children and grandchildren. My generation feels blessed. Many of us had free university education, affordable housing and final-salary pension schemes. To give those graduating today a similar advantage would cost a substantial six-figure sum. Giving money is the topic of another day — it is not as simple as it sounds — but it is now the subject of many client meetings.
Finally, how about spending it? I have seen too many clients postpone retirement because of the income or status employment brings, only to meet life-changing events such as dementia and terminal illness soon after they finally stopped work.
I have one client who was successful enough to retire in his 50s. He and his wife travel around the world, staying in Airbnb homes. Others have gone back to university; one is writing a book. I have huge admiration for them.
Accumulating wealth is hard work. It should not become a burden to us once we have succeeded, causing us to fret anxiously about its preservation. Remember that at the same time as your savings are being eroded your dreams are becoming more expensive. Live life!
Charles Calkin is a financial planner at wealth manager James Hambro & Partners